A comparative analysis of accounting and financial practices associated with efficiency of cooperative rural banks in Sri Lanka

A comparative analysis of accounting and financial practices associated with efficiency of cooperative rural banks in Sri Lanka

In Sri Lanka, the formal rural financial sector comprises a large number of small financial institutions (SFIs) that are highly criticised for weak performance. The weak performance has been attributed to poor governance. Consequently, the sustainability of these institutions is uncertain. This uncertainty adversely affects economic growth as investment in agriculture and small enterprises by poor rural households relies on the provision of microfinance services. Hence, the Sri Lankan Government and Central Bank of Sri Lanka have implemented legislation to strengthen SFIs. Further, attention to the efficiency of SFIs in Sri Lanka is of concern to the general public given the recent malpractice-related collapses of several formal and informal financial institutions.

The cooperative rural banks (CRBs) in Sri Lanka provide a comprehensive network throughout the country and make a substantial contribution to rural credit activities. As formal SFIs, these CRBs have gained an increasing share of financial assets, which has been particularly helpful for satisfying the growing demand for loans and advances from people living in rural areas. This study aims to evaluate the overall efficiency of CRBs in Sri Lanka. The study provides evidence on the accounting practices and financial practices of CRBs and some elements in the corporate governance mechanisms of financial institutions.

Data envelopment analysis (DEA) is used to measure efficiency. A comparative analysis of the efficiency of CRBs operating in Sri Lanka is undertaken. Two main approaches are used to evaluate efficiency. Input and output variables are selected for the intermediation and asset approaches. The results from both approaches show that relatively few CRBs operate efficiently. Further, the efficiency of CRBs in Sri Lanka has declined during the study period. Variables for CRBs specific characteristics are also tested for relationships with CRBs size.

The evaluation of accounting and financial practices reveals that most sample CRBs deviate from the normative benchmarks. Many CRBs provide accounting information only to fulfil legal requirements rather than with the objective of providing information useful for decision-making purposes. With regards to financial practices, performance relative to best practice is below the benchmarks for most sample CRBs. In this context, the level of risk exposure of these CRBs is very high. As a consequence, the possibility of failure to meet the going concern criteria is raised, especially at a time when global financial crises are impacting all financial institutions.

Analysis of the associations of efficiency with accounting and financial practices shows that efficiency in intermediation is correlated with accounting practices and indicators of sound financial practice (assets quality, loan portfolio yield, operating efficiency and operating self-sufficiency). Further, efficiency in asset transformation is associated with capital adequacy, loan portfolio yield and operational self-sufficiency.

The findings of this study contribute to understanding the underlying problems for efficiency in particular CRBs in Sri Lanka. Further, they can assist regulators with the development of policies affecting the small financial institutions generally and CRBs in particular.